The following is excerpted from the final chapter of Wade Pfau’s new book, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement. It is available at Amazon. All of the issues and questions discussed are explained with much more detail throughout the book.
It is important to understand the complex way insurance products work for retirement income. Here is a list of important questions to answer for the three major types of annuity products.
First, Exhibit 9.4 covers income annuities (also called single-premium immediate annuities or SPIAs). This list is relatively short. Exhibit 9.5 then covers questions for variable annuities, and Exhibit 9.6 is for fixed-index annuities (also called equity-index annuities). Some questions overlap, but others are quite different or are not relevant for all types of annuities. These lists are provided without further comment.
Exhibit 9.4
Questions to ask about an income annuity
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Income guaranteed amount
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What is the minimum guaranteed amount of lifetime income?
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Guaranteed withdrawal rates
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What is the guaranteed payout rate? How does it vary by age and length of deferral period?
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Other withdrawal features
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Does the contract provide liquidity to take nonguaranteed withdrawals? (Answering yes is uncommon)
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Death benefit
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What are the death benefit provisions, such as cash refund, installment refund, or period certain payments?
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Insurance company credit rating
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What credit ratings has the insurance company earned from the major credit rating agencies?
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For deferred-income annuities (DIAs), make sure you understand how the annuity works with respect to its various features. This will help to assess the potential upside and liquidity to be compared with an income annuity. Exhibit 9.5 provides questions for variable annuities.
Exhibit 9.5
Questions to ask about a variable annuity
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Deferral Period
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Rollup rate
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Is the rollup rate simple or compounded?
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Other rollup features
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How long will the rollup rate be applied?
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Step-up frequency
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How frequently are step-up opportunities provided?
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Stacking
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Do step-ups stack on top of rollups?
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Vesting frequency
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How frequently are step-ups and rollups vested into the benefit base?
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Distribution Period
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Income guaranteed amount
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What is the minimum guaranteed amount of lifetime income as determined by the interaction of rollup rates and withdrawal rates after an assumed deferral period?
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Guaranteed withdrawal rates
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What are the guaranteed withdrawal rates? Do they depend on the age at first guaranteed withdrawal? Or do they depend on age at contract issue and length of deferral period?
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Adjustment for couples
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Are withdrawal rates or fees adjusted for couples relative to singles?
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Other withdrawal features
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Does the contract provide liquidity to take nonguaranteed withdrawals?
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Impact of nonlifetime withdrawals
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How does the amount of guaranteed lifetime income adjust to nonguaranteed withdrawals (including excess withdrawals beyond the guaranteed amount)?
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Death benefit
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What are the death benefit provisions?
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Risk Management Approach
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Maximum allocation to risky assets
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What is the maximum allowed allocation for risky assets?
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Range of investment offerings
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What are the fund choices for the subaccount investments?
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Other restraints on investment allocation
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Are there any other requirements about using volatility-controlled funds or holding cash positions?
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Variable annuity and subaccount fees
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What are the ongoing mortality and expense charges? What fees are applied to the investment options in the subaccounts? Are these fees applied to the contract value, the benefit base, or some other metric for the annuity?
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Additional fees for guarantee rider
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What are the ongoing fees for optional guaranteed living and death benefits? Are these fees applied to the contract value, the benefit base, or some other metric for the annuity?
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Fee adjustments
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How much flexibility does the insurance company maintain to adjust fees? What are the maximums?
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Surrender charges
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What surrender charge schedule is applied to excess distributions in the early years of the contract?
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Insurance company credit rating
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What credit ratings has the insurance company earned from the major credit rating agencies?
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Finally, Exhibit 9.6 provides questions for fixed-index annuities.
Exhibit 9.6
Questions to ask about a fixed-index annuity
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Deferral Period
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Linked index
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What financial market index is used for crediting interest?
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Downside protection
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Is principal protection provided? What is the worst-case interest to be credited? What is the guaranteed minimum surrender value?
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Crediting method
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What crediting method is used to determine upside participation?
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Rollup rate
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Is there a rollup rate? Is it simple or compounded?
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Other rollup features
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How long will the rollup rate be applied?
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Step-up frequency
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How frequently are step-up opportunities provided?
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Possibility for step-ups
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Given the crediting method, how likely are step-up opportunities?
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Stacking
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Do step-ups stack on top of rollups?
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Vesting frequency
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How frequently are step-ups and rollups vested into the benefit base?
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Distribution Period
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Income guaranteed amount
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What is the minimum guaranteed amount of lifetime income as determined by the interaction of rollup rates and withdrawal rates after an assumed deferral period?
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Guaranteed withdrawal rates
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What are the guaranteed withdrawal rates? Do they depend on the age at first guaranteed withdrawal? Or do they depend on age at contract issue and length of deferral period?
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Adjustment for couples
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Are withdrawal rates or fees adjusted for couples relative to singles?
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Other withdrawal features
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Does the contract provide liquidity to take nonguaranteed withdrawals?
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Impact of nonlifetime withdrawals
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How does the amount of guaranteed lifetime income adjust to nonguaranteed withdrawals (including excess withdrawals beyond the guaranteed amount)?
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Death benefit
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What are the death benefit provisions?
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Risk Management Approach
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Changes to crediting method
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How much flexibility does the insurance company maintain to adjust parameters with the crediting method at each new term?
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History of crediting method
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Has the insurance company demonstrated the ability to not adjust crediting method parameters in an adverse direction at least during the surrender period?
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Additional fees for guarantee rider
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What are the ongoing fees for option guaranteed living and death benefits? Are these fees applied to the contract value, the benefit base, or some other metric for the annuity?
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Fee adjustments
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How much flexibility does the insurance company maintain to adjust rider fees? What are the maximums?
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Surrender charges
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What surrender charge schedule is applied to excess distributions in the early years of the contract?
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Insurance company credit rating
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What credit ratings has the insurance company earned from the major credit rating agencies?
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Retirees may wonder about which type of annuity to use, and this depends on personal preferences. The variable annuity maintains a contract value that can rise and fall with the markets, creating more upside potential and downside risk than other annuities. The fixed-index annuity offers upside potential and liquidity, but generally less upside potential than a variable annuity and less minimum guaranteed income than an income annuity. Income annuities do not have liquidity, but they are the most efficient way to secure a stream of protected lifetime income with the least amount of assets. The analysis makes clear that including risk pooling as a retirement income tool helps to lay a foundation for improved retirement outcomes no matter which approach is chosen.
We must step away from the notion that either investments or insurance alone will best serve retirees. More emphasis is needed on different forms of insurance products and how they behave as part of an integrated retirement income plan.
To learn more about annuities, as well as life insurance and investments for retirement, please find my new book, which is available through Amazon.
Wade D. Pfau, Ph.D., CFA, is the curriculum director of the Retirement Income Certified Professional program at The American College in King of Prussia, PA. He is also a principal and director at McLean Asset Management and RetirementResearcher.com.
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